You are planning to go on a one-week vacation in Europe in May 2026. Today's exchange rate is 0.88 euros per dollar. You are trying to determine how many dollars you will (likely) need in order to have 1,000 euros when you exchange your dollars for euros in 12 months. You expect a U.S. inflation rate of 4.1 percent and a Eurozone inflation rate of 2.2 percent in the next twelve months.

Based on this information and ignoring other short-term factors that may affect the exchange rate, you expect that you will need ______ dollars to purchase 1,000 euros.

Round your answer to the nearest dollar.

Question

You are planning to go on a one-week vacation in Europe in May 2026. Today's exchange rate is 0.88 euros per dollar. You are trying to determine how many dollars you will (likely) need in order to have 1,000 euros when you exchange your dollars for euros in 12 months. You expect a U.S. inflation rate of 4.1 percent and a Eurozone inflation rate of 2.2 percent in the next twelve months.

Based on this information and ignoring other short-term factors that may affect the exchange rate, you expect that you will need ______ dollars to purchase 1,000 euros.

Round your answer to the nearest dollar.

BlackTom AI · Accepted Answer

We start by restating the scenario and the data provided. You have 0.88 euros per dollar today, and you expect US inflation of 4.1% and Eurozone inflation of 2.2% over the next 12 months. You want to know how many dollars you'll likely need in 12 months to obtain 1,000 euros, ignoring other short-term factors.

First, understand how inflation differences affect the exchange rate under relative purchasing power parity (PPP). If the domestic price level rises faster than the foreign price level, the domestic currency tends to depreciate relative to the foreign currency. In this case, USD inflation (4.1%) is higher than EUR inflation (2.2%), so the USD is expected to depreciate relative to the euro. Therefore, the euro per dollar rate E_t is expected to be higher in 12 months than today’s E_0 = 0.88.

A common relative-PPP calculation is E_t = E_0 × [(1 + inflation_USD) / (1 + inflation_EUR)]. Plugging the numbers in:
- (1 + 0.041) = 1.041
- (1 + 0.022) = 1.022
- Ratio = 1.041 / 1.022 ≈ 1.019 (roughly 1.019)
- E_t ≈ 0.88 × 1.019 ≈ 0.897 (in euros per dollar)

Next, determine how many dollars are needed to secure 1,000 euros at the future rate. If 1 USD buys E_t euros, then to obtain 1,000 euros you need Dollars = 1,000 / E_t.
- Dollars ≈ 1,000 / 0.897 ≈ 1,115.7

Rounding to the nearest dollar gives about 1,116 dollars. Note that small differences in the exact rounding at intermediate steps (e.g., using 1.041/1.022 ≈ 1.0190 vs. 1.0195) can shift the final rounded dollar amount slightly (for instance, toward 1,110 or 1,116). The key idea is that the higher US inflation relative to Eurozone inflation implies more dollars are needed in 12 months to buy the same 1,000 euros.

In summary, applying relative PPP with the given inflation rates yields a future euro-per-dollar rate just under 0.90, which translates to a little over 1,100 dollars (specifically around 1,116) required to obtain 1,000 euros in 12 months.

FA25 ECON 302 002 Homework #12 (International Finance)

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